Dividends of a capital nature?

The Court of Appeal has upheld the decisions of the lower tribunals that distributions made out of share premium account by a Jersey company to a UK shareholder were not "dividends of a capital nature": Beard v HMRC [2025] EWCA Civ 385. Under Jersey law, the share premium was freely distributable such that the distribution out of share premium account amounted to an income distribution in the same way as other payments out of distributable profits. It was important that the method used to make the distribution in this case was the same method used to make normal distributions of trading profits.

Background

The case concerns the receipt by a UK resident shareholder in Glencore PLC of cash distributions made out of share premium account. Glencore was a publicly listed company incorporated in Jersey and domiciled in Switzerland. No withholding tax was imposed on the distributions by the Swiss tax authorities.

HMRC assessed the taxpayer, Mr Beard, to income tax on the distributions and Beard appealed arguing that either the distributions were not "dividends" at all or, if they were dividends, they were "dividends of a capital nature" under ITTOIA 2005 s.402 and so subject to capital gains tax rather than income tax. The FTT rejected those arguments and Beard's appeal against that decision has now been rejected by both the UT and Court of Appeal.

On the question whether a distribution is a dividend, the Upper Tribunal referred to the earlier case of First Nationwide. This case decided that it is necessary to consider the meaning of dividend as a matter of ordinary usage for English law purposes, then look at the foreign law governing the relevant payment. In this case, the mechanism used to make the distribution was Part 17 of the Companies (Jersey) Law 1991. It was common ground that Part 17 was the mechanism enabling the payment of dividends out of profits. This was equally the case as in First Nationwide (albeit that that case concerned Cayman law) which also concerned distributions made out of share premium under the same statutory scheme as used for making ordinary distributions of profits. The conclusion that the payments were "dividends" was inescapable. The taxpayer did not pursue this point before the Court of Appeal, where the focus of the case was on the question whether the distribution was a dividend of a capital nature.

Court of Appeal decision

The decision of the Court of Appeal contains a very instructive discussion of the role of expert evidence concerning foreign law and of the ability of the appeal courts to consider appeals involving the findings of fact dealing with foreign law. In particular, Lady Justice Falk stated that, "I do not consider that the need for challenges to findings of fact to meet the threshold established by Edwards v Bairstow should make a material difference to the approach of an appellate court to findings of foreign law. To the extent that the relevant legal system is one that applies an approach similar to that under English law, the application by a lower tribunal or court of its own skill and experience will necessarily require the application of legal principles, such as principles of statutory interpretation. Inherent in that process, therefore, must be the scope for error which can properly be characterised as an error of law, as Lord Radcliffe contemplated. So while an appellate court or tribunal is not in the same position as the fact-finding tribunal, if it considers that that tribunal has erred in its application of legal principles then it would be able to conclude that it made an error of law".

Putting this into context, the court noted that the "proper interpretation and scope of the expressions "dividend" and "of a capital nature" are undoubtedly questions of (UK) law. In particular ... the fact that a foreign legal system might label something as "capital" cannot determine whether a transaction does in fact give rise to capital rather than income. Rather, whether it does or does not depends on the factual characteristics of the transaction, determined with reference to the relevant foreign law, to which UK tax law must then be correctly applied. Put another way, the dividing line between income and capital is drawn by UK law, and the task of the fact-finding tribunal is to apply that law to the facts as found".

In terms of determining whether a dividend was capital in nature, following a review of relevant case law, the court stressed that the mechanism or form of the distribution is an essential element. "In effect, therefore, the question whether the corpus of the asset remained intact is not a separate or different test from one that focuses on the machinery employed. Rather, the mechanism or form of the distribution is an essential element in determining whether the corpus, or capital, of the asset is to be regarded as left intact. Put another way, the mechanism is key to answering the question of whether the corpus is intact, and will... be determinative." However, the court noted that "while mechanism is key it is not necessarily conclusive in all cases" and "it might be necessary to look behind the mechanism in some cases to identify the true substance".

The Court also noted that (a) the origin of the profit or amount distributed does not affect the position and (b) it is necessary to look behind labels that might be applied in the relevant foreign law.

In this case, it was clear that Jersey law no longer distinguished between a distribution out of share premium account and a distribution of profits, such that the maintenance of capital principle no longer applied in Jersey. In this case, the fact was that the distribution was made under Part 17, which was also the mechanism used to distribute normal profits. The fact that Jersey law treated share premium as capital for the different purpose of a Part 12 reduction in capital "tells us nothing about it treatment when it is distributed under the different mechanism of Part 17". The Court also rejected the taxpayer's reliance on the fact that the share premium account was a capital account under Jersey law both for the reason that labels applied under foreign law are irrelevant and, more importantly, the divide between income and capital is one for UK law rather than foreign law.

Equally, the fact that the distribution in this case could have been made under Part 12 of Jersey Company Law which dealt with reductions of capital accounts did not affect the issue. What was important was not the funds from which the payment was made, but rather the form in which the payment is made. (HMRC accepted that a capital reduction under Part 12 would have been treated as giving rise to a capital rather than income receipt.)

As a result, the Court has rejected the taxpayer's arguments that the FTT was not entitled to conclude that the distributions in this case were not dividends of a capital nature.

Comment

For income tax purposes, there remains a distinction between distributions received from UK resident and non-UK resident companies. Any distribution received by a UK taxpayer from a UK company is subject to income tax (whether or not capital in nature). However, income tax is only payable on dividends which are not of a capital nature from a non-UK company.

The decision appears to accord with HMRC guidance on the difference between an income and capital distribution. HMRC state at SAIM5210 that: "Whether a dividend is income or capital in nature is determined by reference to the mechanism of distribution under the constitutive law of the territory where the company is incorporated or registered and its implications for the company making the distribution. The question is whether or not the 'corpus of the asset' is left intact after the distribution. If not, the receipt will be a capital receipt; if it is, the payment will be chargeable as income."